Investors see deflation as bigger threat than inflation

Despite trillions of dollars in monetary stimulus unleashed by major central banks in recent years, investors see deflation as a bigger threat than inflation over the next 12-24 months, according to a new survey.

Around 25 percent of investors expect gold to fall below $1,200 an ounce by the end of the first quarter of 2014, while another 25 percent or so expect it will trade between $1,200 and $1,250, the survey showed. The yellow metal is currently trading at $1,239.

Mounting deflationary pressures in the euro zone, for example, have become a serious concern, prompting the European Central Bank (ECB) cut its benchmark rate to a record low of 0.25 percent in early November.

Euro zone inflation fell to 0.7 percent on year in October – its lowest since November 2009 – triggering worries that the region is at risk of a Japan-style deflationary rut.

"Low/falling inflation suggests that right now deflation is maybe more of a risk than rising inflation in developed countries. Falling inflation reflects significant spare capacity globally and soft commodity prices," said Shane Oliver, head of investment strategy and chief economist at AMP Capital.

"In the current environment, a slide into deflation would likely be bad. Falling wages and prices would make it harder to service debts. And when prices fall people put off decisions to spend and invest, which could potentially threaten a relapse into recession," he said.

The biggest preoccupation for investors, however, remains the prospect of the Federal Reserve tapering its asset purchases, according to the survey. The majority expect the central bank will first adjust the pace of its monthly bond purchases in March 2014.

While tapering expectations have triggered a rise in U.S. government bond yields this year, the majority of investors do not expect a large reaction from the Treasury market once it starts.

The threat of deflation

Richard Duncan, Chief Economist at Blackhorse Asset Management says QE has caused an enormous credit bubble which could deflate and cause extreme deflation around the world.

Around 45 percent expect 10-year U.S. Treasury yields will remain in the 2.5-3.0 percent range by the end of the first quarter, while 40 percent see yields between 3.0-3.5 percent. 10-year treasury yields currently stand at 2.73 percent.

Top asset class

Nearly 60 percent of investors believe stocks will provide the best returns over the next three months, with European equities expected to outperform.

The majority, or 28 percent, of survey respondents also said they believed the most prominent cross asset rotation over the next 12 months would be from safe-haven bonds to equities.

Meanwhile, 25 percent expect a rotation from U.S. stocks to other equity markets, such as Europe, Japan or emerging markets, will take place.